THE  MARKETING 
OF  AMERICAN 
RAILROAD  SECURITIES 


OTTO  H.  KAHN 


Reprinted  from 

The  Forum 


354  Fourth  Avenue 
NEW  YORK  CITY 


THE  MARKETING  OF  AMERICAN 
RAILROAD  SECURITIES* 


By  Otto  H.  Kahn 


Memorandum  in  explanation  of  the  various  methods  of 
marketing  securities  and  the  experience  and  considerations 
upon  which  is  founded  the  existing  custom  of  the  principal 
American  railroad  companies  of  marketing  their  securities 
through  bankers,  and  more  particularly  the  practice  of  nu- 
merous railroad  companies  in  dealing  with  some  particular 
banker  or  banking  group. 


AUi 


CONDITION  of  controlling  force  in  every  public 
service  industry  and  having  particularly  important 
consequences  in  connection  with  American  railways,  is  the 
persistent  necessity  for  extensions  and  improvements  that 
constantly  require  the  investment  of  additional  capital. 

Some  measure  of  the  extent  of  this  continuing  absorption 
of  capital  is  supplied  by  the  records  of  the  Interstate  Com- 
merce Commission,  which  show  that  between  July  1,  1907, 
and  the  same  date  in  1912,  the  railways  reporting  to  the 
Commission  found  it  necessary  to  add  the  immense  sum  of 
$2,823,220,561  in  cash  to  the  actual  cost  of  their  facilities. 

It  has  been  estimated  by  several  high  authorities  that  in 
order  to  meet  with  any  degree  of  adequacy  the  requirements 


*[This  memorandum  was  written  shortly  before  the  outbreak  of  the  European 
war.  The  then  anticipated  occasion  for  publishing  it  did  not  arise.  It  is  now 
published  exactly  as  it  was  written  at  that  time.  The  financial  developments 
broaght  about  by  that  war  only  emphasize  the  value  and  importance  of  the  services 
which  bankers  are  qualified  to  render.  The  economic  changes  resulting  from  the 
war  do  not  call  for  any  modification  of  this  memorandum  except  only  in  respect 
to  what  is  stated  therein  as  to  the  placing  of  American  railroad  issues  in  Europe, 
inasmuch  as  such  transactions  will  be  impracticable  for  the  time  being  and  doubt- 
less for  some  years  to  come. — Otto  H.  Kahn.] 


1 


of  the  situation  for  new  construction,  for  additional  main 
tracks,  sidings  and  yards,  for  equipment  and  terminal  facili- 
ties, for  elimination  of  grade  crossings,  especially  in  the 
larger  cities,  for  block  signaling  and  other  safety  appliances, 
and  the  requisite  general  strengthening  and  improvement 
of  existing  properties,  expenditures  are  called  for,  aggregat- 
ing from  $700,000,000  to  $1,000,000,000  each  year  for  a 
series  of  years  to  come. 

In  other  words,  there  is  a never-ceasing  demand  in  the 
United  States  for  more  and  better  railway  services,  and 
unless  this  demand  is  to  remain  unsatisfied  the  railway  man- 
agements must  find  some  way  to  attract  to  the  railway  in- 
dustry an  uninterrupted  and  steadily  augmenting  flow  of 
new  capital. 

The  sole  means  available  to  obtain  from  investors  the 
additional  capital  necessary  to  meet  this  constant  pressure 
for  extensions  and  improvements  is  the  sale  of  shares  of 
stock,  mortgage  bonds  or  other  securities.  In  addition,  a 
large  volume  of  securities  must  be  distributed  annually  in 
order  to  refund  maturing  obligations.  For  this  reason,  the 
determination  of  the  best  method  of  disposing  of  the  se- 
curities required  to  obtain  new  capital  constitutes  a prob- 
lem which  every  railway  management  must  do  its  best  to 
solve. 

The  prime  necessities  of  a satisfactory  method  are— 

( 1 ) that  the  capital  requirements  of  a program  covering  a 
considerable  period  and  requiring  a considerable  total  outlay  may 
be  provided  for  in  advance  and  with  certainty,  and 

(2)  that  the  price  obtained  for  railroad  securities  shall  be 
as  high  as  the  circumstances  warrant. 

It  is  obvious  that  neither  of  these  conditions  can  be  met 
by  any  method  that  does  not  commend  the  investment  as 
strongly  as  the  facts  justify  to  the  largest  possible  number 
of  potential  investors. 


2 


Three  methods  of  marketing  railway  securities  may  be 
considered.  These  are: 

A.  Public  offerings,  calling  for  bids. 

B.  Offerings  to  shareholders  at  a fixed  price. 

C.  By  negotiation  with  investment  bankers. 

These  methods  will  be  examined  and  their  relative  ad- 
vantages and  disadvantages  (if  any),  as  may  appear,  dis- 
cussed. 

I 

The  Existing  Practice 

As  a rule,  railroad  companies  of  the  United  States,  like 
those  of  other  countries,  market  their  securities  by  selling 
them  either  to  or  through  bankers.  Even  in  cases  where  se- 
curities are  offered  for  pro  rata  subscription  to  a corpora- 
tion’s stockholders  is  it  customary  for  the  corporation  to 
protect  itself  by  arranging  with  bankers  to  underwrite,  or 
to  form  a group  to  underwrite,  their  sale,  that  is,  to  agree  to 
purchase  such  of  the  securities  as  are  not  taken  by  the  stock- 
holders. 

The  cases  in  which  railroad  companies  have  successfully 
sold  their  securities  direct  to  the  investor  are  exceedingly 
rare. 

Most  of  the  important  railroad  companies  make  a prac- 
tice of  dealing  with  a particular  banking  house  or  a particu- 
lar group  of  bankers  in  marketing  securities.  This  relation- 
ship rarely  rests  on  formal  contract.  The  cases  in  which  a 
railroad  company  formally  appoints  a banking  firm  its  fiscal 
agent  or  banker  are  few.  As  a rule,  the  relationship  is 
informal  and  tacit. 

A railroad  company  gradually  comes  to  recognize  a par- 
ticular banking  house*  as  its  banker  so  that  in  case  it  has 
securities  to  be  sold  or  underwritten  it  naturally  looks  to 
that  banking  house  to  take  charge  of  the  business,  especially 
in  large  issues  of  securities. 

*The  term  “Banker”  or  “Banking  Firm,”  as  used  in  this  article,  is  meant  to 
include  any  financial  concern,  private  or  corporate,  engaged  in  the  business  of 
purchasing  and  issuing  securities. 


3 


From  the  nature  of  the  case,  there  rarely  can  be  a stand- 
ing agreement  or  understanding  as  to  the  prices  and  terms 
upon  which  a banker  will  purchase  or  underwrite  securities 
for  a railroad  company  whose  business  he  regularly  handles. 
Usually  the  prices  at  which  securities  can  be  sold  or  under- 
written depend  too  much  upon  time  and  circumstances  to 
render  any  such  undestanding  practicable. 

Therefore,  the  relationship  between  a railroad  company 
and  its  banker  is  of  the  most  indefinite  character.  The  ex- 
istence of  such  a relationship  means  not  only  that  when  the 
railroad  has  securities  to  be  sold  or  underwritten,  it  first 
goes  to  its  banker  and  endeavors  to  negotiate  an  arrange- 
ment, but  it  means  that  the  railroad  has  at  its  disposal  con- 
tinuously the  services,  skill,  standing,  experience,  advice  and 
financial  potency  of  the  banker. 

The  banker’s  functions  are,  for  instance,  to  keep  track  of 
the  financial  situation  and  requirements  of  the  railroad,  to 
assist  in  the  preparation, — in  advance  of  the  need — of  a 
proper  and  serviceable  system  for  financing  such  require- 
ments, to  advise  as  to  the  class,  kind  and  denomination  of 
securities  to  be  issued  and  as  to  the  best  time  for  selling  them, 
so  that  his  clients  may  not  miss  an  opportune  moment  for 
meeting  their  requirements,  to  scrutinize  the  mortgages  and 
deeds  of  trust  under  which  securities  are  to  be  issued,  and 
to  indicate  from  his  survey  of  the  markets  of  the  world  his 
judgment  as  to  the  amount  of  securities  which  could  be  ab- 
sorbed in  one  or  the  other  market. 

The  terms  of  a negotiation  are  by  no  means  imposed  by 
the  banker,  for  it  is  easily  within  the  means,  and  is  as  an  im- 
portant and  responsible  duty,  of  those  conducting  the  ne- 
gotiations on  behalf  of  the  railroad  company,  to  acquaint 
themselves  with  the  reasonable  market  value  of  the  securities 
which  it  desires  to  sell  and  to  insist  upon  obtaining  a fully 
adequate  price. 

The  terms  are  the  subject  of  negotiation  and  agreement, 
and  if  a railroad  company  cannot  secure  what  it  considers 


4 


satisfactory  terms  from  the  banker  it  either  postpones  the 
business  or  takes  it  to  other  bankers. 

Competition,  the  prevailing  market  prices  of  existing 
issues,  fix  very  closely  the  prices  at  which  new  securities  can 
be  sold  to  investors,  and  competition  and  custom  likewise 
regulate  the  profits  and  commissions  of  bankers.  The  banker 
who  would  make  a practice  of  marketing  the  securities  of 
his  clients  at  prices  materially  below  the  prevailing  prices, 
would  soon  lose  his  clients. 

All  of  this  is  equally  true  of  the  relations  between  a rail- 
road company  and  a banker  who  happens  to  sit  upon  its 
board  of  directors.  The  influence  which  the  directorship 
gives  to  a banker  in  dealing  with  the  corporation  of  which 
he  is  a director,  has  been  very  greatly  exaggerated  and  the 
conditions  under  which  a banker  deals  with  such  a corpora- 
tion have  been  much  misunderstood  and  misinterpreted. 

In  the  matter  of  the  prices  at  -which  securities  are  ac- 
quired, it  is  by  no  means  an  aid  or  advantage  to  a banker  to 
be  on  the  board  of  a railroad,  and  it  is  easily  susceptible  of 
proof  that  railroads  dealing  with  bankers  who  sit  on  their 
boards,  obtain  certainly  as  favorable  prices  for  their  secur- 
ities as  railroads  of  similar  credit  and  standing  not  having 
bankers  on  their  directorate. 

Bankers  advise  on  the  methods,  times,  etc.,  for  the  issue 
of  securities,  but  do  not  themselves  determine  or  control  the 
prices  at  which  they  buy  a company’s  securities.  Nor  do 
banking  interests  dominate  the  Boards  of  Directors  of  rail- 
roads nowadays,  as  they  undoubtedly  did,  to  a considerable 
extent,  in  former  days. 

The  instances  are  comparatively  infrequent  where  a rail- 
road company,  after  having  once  established  relations  with 
a strong  banking  house  which  has  effectually  handled  its  se- 
curities and  gained  its  confidence,  finds  it  to  its  interest  to 
change  that  relationship — a relationship  which,  whilst  not 
limiting  the  railroad’s  freedom  of  action  according  to  its 
own  judgment  of  its  best  interest,  does  involve  upon  the  part 


5 


of  the  bankers  certain  definite  and  continuous  duties  and 
obligations,  more  fully  referred  to  later  on. 

It  is  manifest,  on  the  other  hand,  that  a railroad  company 
usually  is,  and  always  ought  to  be,  free  to  terminate  its  re- 
lationship with  its  bankers. 

That  changes  in  the  relationships  between  railroads  and 
bankers  do  occur  quite  frequently  is  indicated  by  the  varia- 
tions which  take  place  in  the  course  of  time,  in  the  connec- 
tions, and  the  relative  influence  and  position  of  the  promi- 
nent banking  firms  which  deal  in  railroad  securities. 

It  is  now  claimed  in  certain  quarters  that  the  practice 
above  outlined  is  wrong  and  that  railroad  companies  would 
do  better  if  they  would  discontinue  the  practice  of  dealing 
regularly  with  particular  banking  houses,  and,  whenever 
they  have  securities  to  sell,  would  offer  them  for  competitive 
sale,  regardless  of  past  affiliations. 

Some  even  urge  that  bankers  should  not  be  used  at  all, 
not  even  upon  a competitive  basis,  but  that  the  railroad  com- 
panies should  sell  their  securities  directly  to  their  own 
stockholders  or  to  investors,  preferably  offering  them  for 
public  competition  and  accepting  the  bids  of  the  highest 
bidders. 


II 

The  services  of  the  bankers  in  the  sales  of  large  issues 
of  securities  are,  with  rare  exceptions , essential  to  assure 
success. 

In  selling  all  kinds  of  commodities  a certain  degree  of 
skill,  efficiency  and  experience  is  required.  Some  com- 
modities are  more  easily  sold  than  others.  Most  commodi- 
ties can  be  sold,  in  limited  quantity  and  at  distinct  conces- 
sions in  price,  at  public  offering  or  auction. 

But  it  is  recognized  that  the  public  reached  by  any  such 
offering  is  never  more  extensive  than  the  extent  of  the  inter- 
est which  through  advertising  and  otherwise  it  is  possible 
to  arouse,  and  of  the  general  knowledge  of  the  character 


6 


and  quality  of  the  commodity  offered,  and  that  to  at  least  the 
extent  in  which  bidders  are  uncertain  as  to  quality  their 
bids  are  below  actual  value.  Railway  securities  are  com- 
modities having  widely  varying  values  both  as  to  different 
securities  at  the  same  time  and  as  to  the  same  securities  at 
different  times.  They  are  offered  to  purchasers  who  are 
asked  to  exchange  for  them  portions  of  their  capital  posses- 
sions, and  the  timidity  of  investors  is  a well-known  and  im- 
portant element  in  the  problem  of  distribution. 

Hence,  whatever  corporation  offers  its  securities  at  pub- 
lic auction  cannot  expect  to  receive  bids  from  investors  who 
are  outside  of  the  relatively  limited  field  in  which  the  cor- 
poration and  its  management  and  the  intrinsic  merits  of  the 
particular  securities  offered  are  known. 

In  the  case  of  railways  in  the  whole  region  west  of 
the  Mississippi  river  no  local  market  of  adequate  propor- 
tions can  be  counted  on,  for,  as  is  well  known,  the  people 
of  this  region  find  other  local  investments  so  much  more 
profitable  and  satisfactory  that  they  are  generally  averse  to 
investing  in  railway  securities  to  any  large  extent. 

Those  who  advocate  that  railroad  companies  should 
make  a practice  of  selling  their  securities  directly  to  their 
stockholders,  or  to  investors  without  the  intervention  of 
bankers,  ignore  the  conditions  under  which  modern  busi- 
ness on  a large  scale  must  be  done.  It  is  safe  to  say  that 
there  is  no  business  which  requires  in  greater  degree  the 
combination  of  skill,  experience,  capital  and  reputation 
than  is  required  in  the  sale  of  securities  on  a large  scale. 

A railroad  company  cannot  be  expected  to  possess  that 
combination.  The  sale  of  securities  is  not  its  business.  It 
is  simply  incident  to  its  business,  or  rather  a means  of 
placing  it  in  a position  to  carry  on  its  business.  Accord- 
ingly, when  it  has  securities  to  sell,  it  naturally  turns  to  those 
who  are  skilled,  efficient  and  trustworthy  in  the  sale  of  se- 
curities. 

Railroads  would  suffer  seriously  in  credit  from  unsuc- 
cessful efforts  to  sell  securities  by  public  subscription. 


7 


If  railroads  offered  bonds  direct  for  public  subscription 
in  limited  amounts,  the  result  might  be  fairly  satisfactory 
in  good  or  normal  times,  although  even  then,  deprived  of 
the  facilities,  the  skill  and  the  sponsorship  of  responsible 
bankers,  the  prices  obtained  would  probably  be  lower  than 
those  which  would  have  been  realized  by  dealing  with  a 
banker,  to  say  nothing  of  the  uncertainty  in  which  the  rail- 
road would  necessarily  find  itself  as  to  what  portion  of  the 
funds  it  requires  would  be  realized  as  the  result  of  the  public 
offering.* 

In  unfavorable  times,  of  course,  the  public’s  response 
would  be  small,  at  times  exceedingly  small.  It  occurs  very 
frequently  that  bankers  or  syndicates  have  to  carry  issues  of 
bonds  which  they  have  purchased  for  many  months  or  even 
years,  until  investment  demand  returns.  If  an  issue  of  bonds 
offered  by  a railroad  for  competitive  bids  on  direct  public 
subscription  resulted  in  non-success,  the  issue,  if  then  sale- 
able at  all,  could  only  be  disposed  of  at  a very  heavy  sacrifice. 

The  non-success  of  such  public  offering  and  the  conse- 
quent public  knowledge  that  the  railroad  has  been  unable 
to  obtain  the  funds  it  requires,  would  always  cause  grave 
damage  to  a railroad’s  credit,  if  it  did  not  for  the  time  en- 
tirely destroy  it,  would  cause  alarm  amongst  investors,  and 
in  not  a few  cases  might  cause  bankruptcy. 

Even  in  the  case  of  great  cities  like  New  York  whose 
securities  command  the  highest  degree  of  public  confidence 
and  who  are  compelled  by  law  to  make  public  offering  of 
their  securities  and  to  sell  them  to  the  highest  bidders,  the 
highest  bidders  are  usually  banks  and  bankers,  who  buy  the 
securities  in  the  first  instance  for  ultimate  sale  to  investors.* 

Investors  as  a class  prefer  to  buy  even  municipal  se- 

*A  few  weeks  ago  the  Vermont  Valley  Railroad  offered  for  competition  by 
sealed  tenders  an  issue  of  $2,300,000  of  its  6%  one  year  notes.  Although  the 
Vermont  Valley  Railroad  is  a very  prosperous  concern,  having  paid  dividends 
at  the  rate  of  10%  per  annum  for  nine  years,  and  the  notes  have  the  additional 
security  of  being  guaranteed  by  the  Connecticut  River  R.  R.  Co.,  the  offering 
resulted  in  complete  failure,  practically  no  bids  having  been  received. 

•Even  so  exceptional  a security  as  the  Bonds  of  the  State  of  New  York  which 
were  offered  for  public  competition  several  years  ago,  were  not  subscribed  for  by 
the  public  at  prices  equalling  those  bid  by  Bankers,  and  both  issues  in  their 
entirety  were  consequently  allotted  to  Bankers. 


curities  from  bankers  rather  than  directly  from  cities,  be- 
cause they  want  the  benefit  of  the  advice  and  judgment 
which  the  trained  banker  is  competent  to  give,  and  of  the 
moral  responsibility  which  goes  with  them. 

It  is  a matter  not  of  surmise  but  of  recorded  fact  that, 
many  times,  owing  to  the  insufficiency  of  subscriptions  on 
the  part  of  the  general  public,  offerings  of  bonds  by  the  City 
of  New  York  would  have  failed  and  the  City  would  have 
been  subjected  thereby  to  serious  embarrassment  if  it  had 
not  been  for  the  subscriptions  by  banks  and  bankers. 

There  is  no  reason  to  believe  that  the  cities  have  been 
better  off  under  the  practice  of  selling  bonds  at  public  offer- 
ing to  the  highest  bidders  than  they  would  have  been  had 
they  been  permitted  to  deal  privately  with  the  bankers  as 
do  the  railroads.  But,  even  if  it  were  otherwise,  it  is  mani- 
fest that  railroad  companies  could  not  possibly  expect  to 
fare  as  well  as  do  the  municipalities  if  they  had  to  depend 
upon  the  uncertain  and  fluctuating  public  demand  by  at- 
tempting to  sell  their  securities  at  public  offering  to  the 
highest  bidder. 

Especially  does  this  hold  true  in  the  case  of  the  less  strong 
railroads,  for  the  investing  public  at  large  will  neither  go 
to  the  trouble,  nor  possess  the  qualifications,  to  analyze 
for  itself  the  position  of,  and  to  form  a reasoned  estimate 
based  upon  the  compilation  and  study  of  statistical  and  other 
data  as  to  the  degree  of  safety  of,  the  securities  of  the  less 
well-known  properties. 

Such  analysis  and  study  is  one  of  the  functions  of  the 
Investment  Banker  who  in  buying  the  securities  and  offer- 
ing them  for  sale  gives  public  notice,  so  to  speak,  that  he  has 
examined  into,  and  satisfied  himself  as  to,  their  intrinsic 
safety  and  merit,  who  places  the  information  gathered  by 
him  at  the  disposal  of  his  clients  in  convenient  and  easily 
understood  form,  and  who  in  proportion  to  the  weight  of  his 
reputation  and  his  moral  responsibility  enhances  the  salabil- 
ity and  the  standing  of  the  securities  for  which  he  becomes 
sponsor. 


9 


Ill 


The  relationship  which  ordinarily  exists  between  a rail- 
road company  and  its  bankers  is  advantageous  to  the  railroad 
company. 

The  considerations  which  make  a system  under  which 
railroads  would  offer  their  securities  direct  to  the  public 
precarious  and  dangerous,  are  so  commonly  recognized  and 
understood  that  it  may  safely  be  assumed  that  no  well  in- 
formed person  will  seriously  contend  that  it  would  be  either 
safe  or  advantageous  for  railroad  companies  to  pursue  the 
practice  of  marketing  their  securities  without  the  aid  of 
bankers. 

The  criticism  therefore  which  remains  to  be  seriously 
considered  in  a discussion  of  this  subject  is  of  the  practice 
by  which  a railroad  company  regularly  deals  with  a par- 
ticular banker  and  gives  that  banker  the  preference  when 
it  has  securities  to  be  sold  or  underwritten.  The  following 
considerations  are  offered  in  support  of  that  practice: 

1.  A railroad  must  be  certain  of  its  ability  to  secure 
the  necessary  funds  for  its  commitments. 

It  is  of  the  greatest  importance  for  a railroad,  when 
making  commitments  for  expenditures  for  improvements, 
new  construction,  equipment,  etc.,  to  be  certain  that  it  will 
be  able  to  sell  the  requisite  securities  when  such  commit- 
ments come  due  and  must  be  met. 

In  dealing  regularly  with  a banking  house  of  ample 
financial  strength  and  wide  connections  in  America  and 
Europe,  the  railroad  company  is  assured  that  it  will  be  able 
to  obtain  the  requisite  funds,  even  in  unfavorable  times,  be- 
cause the  banking  house,  in  order  to  insure  the  continuity 
of  the  connection  and  the  solvency  of  the  railroad,  cannot  do 
otherwise  than  use  to  the  utmost  the  resources  and  the  facil- 


10 


ities  of  connections  and  credits  at  its  disposal,  to  provide 
for  the  requirements  of  the  railroad. 

If,  on  the  other  hand,  the  railroad  had  been  in  the  habit 
of  selling  its  securities  on  a promiscuously  competitive  basis, 
it  would  have  no  such  friend  in  need,  and  the  various  bond 
and  banking  houses  would  naturally  buy  its  securities  only 
as  it  suited  their  own  purposes.  The  strongest  railroads 
have  found  themselves  in  the  situation  where  large  sums  of 
money  were  imperatively  needed  in  most  unfavorable  times 
and  where  only  their  old  established  claims  upon  their  regu- 
lar bankers  enabled  them  to  obtain  the  necessary  funds. 

It  has  of  late  years  been  a matter  of  not  infrequent  occur- 
rence that  during  the  pendency  of  applications  for  the  ap- 
proval by  a public  service  commission  of  proposed  bond 
issues,  railroads  have  found  themselves  in  need  of  tempo- 
rary financial  accommodation.  Such  accommodation,  if  so 
desired  by  the  railroad  or  if  not  readily  or  opportunely  ob- 
tainable from  the  railroad’s  Bank  connections,  is  furnished 
by  the  railroad’s  banker. 

Furthermore,  in  the  case  of  bonds,  the  application  for 
the  issue  of  which  is  pending  before  a public  service  com- 
mission, it  is  not  unusual  for  the  banker,  at  the  railroad’s 
request,  to  obligate  himself  to  purchase  such  bonds,  subject 
to  the  approval  of  their  issue  by  such  commission,  so  that 
the  railroad  is  protected  against  an  unfavorable  change  in 
the  investment  markets  while  its  application  is  being  con- 
sidered and  is  certain  of  obtaining  the  needed  funds  as  soon 
as  the  application  is  granted. 

The  temporary  financial  accommodation  above  referred 
to,  and  the  definite  sale  of  bonds  in  advance  of,  and  subject 
to  action  by  public  service  commissions,  have  at  times  been 
of  great  service  and  value  to  railroads.  Neither  expedient 
would  be  at  the  service  of  a railroad  if  securities  were  sold 
by  competitive  bidding  among  various  banking  houses. 

Several  of  our  railroads  find  themselves  at  this  time  on 
the  brink  of  financial  difficulties  and  have  applied  to  Bank- 


11 


ers  to  evolve  plans  and  inaugurate  measures  for  their  finan- 
cial rehabilitation  without  the  expense  and  detriment  of  a 
receivership,  and  for  the  strengthening  of  their  impaired 
credit.  The  accomplishment  of  this  task  on  the  part  of  the 
Banker  involves  much  thought  and  study  as  well  as  financial 
risk  and  the  assumption  of  great  moral  responsibility  toward 
investors  who  following  the  Banker’s  advice  may  aid  in 
furnishing  the  requisite  funds  and  who  mainly  look  to  the 
Banker  to  safeguard  such  investments. 

No  Banker  could  reasonably  be  expected  to  undertake 
this  task  and  assume  that  responsibility  if  he  had  to  expect 
that  after  having  devoted  his  time,  effort  and  reputation  to 
the  work,  the  security-issues  of  the  railroad  would  thereafter 
be  thrown  open  to  competitive  bidding,  regardless  of 
whether  or  not  his  own  services  were  faithful  and  efficient 
and  satisfactory  to  the  Board  of  Directors  and  the  Manage- 
ment. 

2.  Value  of  the  banker’ s expert  advice. 

In  dealing  regularly  with  one  banking  house,  a railroad 
obtains  the  benefit  of  expert  advice  as  to  financial  policy, 
as  to  the  best  and  most  opportune  time  for  selling  securities 
and  for  providing  for  its  financial  requirements,  as  to  the 
class  and  kind  of  securities  to  be  issued,  and  as  to  the  best 
method  of  offering  them  to  the  public  here  and  abroad. 

The  element  of  the  selection  of  time  is  of  much  im- 
portance in  itself,  for  it  happens  not  infrequently  that  the 
lapse  of  a single  week  measures  the  difference  between  rea- 
sonably favorable  and  unfavorable  or  even  totally  forbid- 
ding conditions. 

The  ebb  and  flow  of  the  currents  in  the  investment  mar- 
kets depend  on  many  and  complex  conditions  and  considera- 
tions, and  it  is  one  of  the  functions  of  the  competent  banker 
to  keep  himself  posted  as  to  affairs,  aspects  and  prospects  in 
America,  Europe  and  elsewhere,  and  to  anticipate  in  his 


12 


judgment  and  advice  their  results  and  their  effects  upon  the 
money  and  investment  markets. 

The  mortgages  and  trust  deeds  under  which  the  secur- 
ities are  to  be  issued,  before  being  put  in  final  shape,  are 
carefully  gone  over  by  the  banker,  and  his  advice  is  given 
with  the  view  to  creating  the  best  and  most  saleable  instru- 
ment satisfactory  both  to  the  public  and  to  the  railroad  com- 
pany. Such  advice  is  frequently,  especially  in  the  case  of 
large  refunding  mortgages  which  are  meant  to  be  the  prin- 
cipal means  of  raising  money  for  the  railroads  for  years  to 
come,  of  very  great  utility. 

Investors  attach  considerable  importance  to  knowing 
that  the  mortgages,  trust  deeds,  etc.,  and  all  legal  steps  relat- 
ing to  the  issue  of  securities  which  they  are  asked  to  buy 
have  been  carefully  examined  by  counsel  for  bankers  of 
repute  and  experience,  with  a view  to  safeguarding  the 
interest  of  the  holders  of  the  bonds  as  distinguished  from 
those  only  of  the  railroads,  the  makers  of  the  bonds. 

3.  The  value  of  a banker’s  reputation  for  care  in  the 
scrutiny  of  securities  and  in  safeguarding  the  interests  of 
investors. 

The  leading  bankers  could  not  maintain  their  position 
as  such,  if  they  did  not  have  pre-eminently  the  confidence  of 
the  investing  public  and  a large  following  amongst  investors, 
large  and  small,  both  here  and  abroad.  Their  reputation 
for  carefulness  in  connecting  their  name  with  a security, 
thereby  assuming  the  moral  responsibility  for  its  soundness, 
and  for  examining  closely  and  efficiently  the  character  of 
the  security  and  of  the  provisions  of  the  mortgage  or  trust 
deed,  constitute  a distinct  additional  investment  value  to 
the  issues  for  which  they  become  public  sponsors. 

In  this  connection,  it  is  the  banker’s  duty  and  to  his  own 
self-interest  to  protect  and  stand  behind  the  securities  which 
he  has  sold  to  the  public,  just  as  it  is  his  duty  and  to  his  own 


13 


self-interest  to  satisfy  himself  by  careful  investigation  as 
to  the  soundness  of  such  securities,  because  the  banker  whose 
clients  suffer  loss  through  following  his  advice  will  very 
soon  lose  his  reputation  and  the  confidence  and  patronage 
of  his  clients.  He  knows  well  that  such  reputation  and  con- 
fidence are  the  mainstays  of  the  prosperity  and  success  of 
his  own  business  and,  once  forfeited,  are  exceedingly  dif- 
ficult to  regain. 

It  may  safely  be  said,  generally  speaking,  that  such  rail- 
road issues  as  are  known  to  be  under  the  habitual  sponsor- 
ship of  well-known  and  strong  bankers  have  a wider  and 
steadier  market  and  command  better  prices  amongst  in- 
vestors than  those  which  are  not  under  such  auspices  and 
responsibility.  Reference  is  here  made  to  the  observations 
on  a preceding  page  (under  2)  as  to  the  particular  and 
essential  need  of  some  well-known  and  trusted  banker's 
sponsorship  for  the  securities  of  the  less  strong  and  well- 
known  railroads,  in  order  to  induce  investors  to  purchase 
said  securities. 

If  the  sale  of  securities  were  thrown  open  to  competitive 
bidding , the  possession  of  large  capital  would  become  the 
prime,  if  not  the  sole,  requisite  for  dealing  in  securities, 
and  the  financier  or  combination  of  financiers  controlling 
the  largest  amount  of  capital  would  have  a vastly  more  po- 
tent advantage  over  others  than  under  now  existing  condi- 
tions. The  exercise  of  care,  skill,  industry,  scrutiny  and  the 
sense  of  moral  responsibility  toward  clients  which  now  are 
and  always  have  been  the  prerequisite  for  acquiring  the 
reputation  and  the  public  confidence  upon  which  an  Invest- 
ment Banker's  position  depends  and  without  which  it  can- 
not be  maintained  for  any  length  of  time,  would  no  longer 
be  essential. 

4.  Various  factors  combine  to  insure  fair  prices  in  the 
sale  of  securities  by  railroad  companies.  There  is  wide- 
spread misapprehension  as  to  the  profits  made  by  bankers 


14 


and  syndicates  upon  the  underwriting  and  purchase  of  se- 
curities of  railroad  companies. 

There  is  a widespread  misconception  to  the  effect  that 
the  railroads  are  in  the  habit  of  paying  a commission  to  the 
banker  when  selling  securities  to  him.  When  the  banker 
forms  a syndicate  to  underwrite  an  offer  of  securities  to 
shareholders  a fixed  commission  is  naturally  stipulated,  such 
commission  being  commensurate  with  the  advantage  secured 
by  the  railroad  company  in  obtaining  through  the  under- 
writing the  certainty  of  the  success  of  its  offering,  and  with 
the  risk  incurred  by  the  banker  and  the  syndicate  affiliated 
with  him. 

On  the  other  hand,  in  the  case  of  the  sale  of  railroad 
securities  to  or  through  bankers  without  an  offering  to  stock- 
holders, it  is  comparatively  unusual  for  the  sale  to  be  on  a 
commission  basis.  As  a rule,  the  procedure  is  that  the 
banker  makes  a firm  bid  to  the  railroad  for  such  securities  at 
a fixed  price,  said  price  being  the  figure  at  which  he  expects 
to  be  able  to  form  a syndicate. 

In  determining  his  bid,  the  banker  naturally  figures  upon 
a reasonable  margin  of  profit  to  the  syndicate  between  the 
price  at  which  it  takes  the  securities  and  the  price  at  which 
he  estimates  that  it  will  be  able  to  place  the  securities  with 
the  public.  For  his  preparatory  work,  his  responsibility 
and  risk  and  his  services  in  managing  the  syndicate,  the 
banker  makes  a charge  to  the  syndicate , usually  varying 
from  y2  per  cent,  to  1 per  cent. 

The  banker’s  financial  risk  is  by  no  means  ended  with 
the  formation  of  the  syndicate,  as,  in  practically  all  cases, 
he  is  himself  a large  participant  in  the  syndicate — is,  in  fact, 
expected  to  be.  His  moral  risk  and  responsibility  towards 
the  syndicate  is  great,  inasmuch  as  he  is  relied  upon  by  its 
members  to  have  examined  carefully  into  the  soundness  of 
the  security,  to  have  scrutinized  the  mortgage,  to  have  taken 
competent  legal  advice,  to  have  correctly  gauged  the  mo- 
ment and  estimated  the  price  at  which  the  securities  can  be 

15 


advantageously  placed  with  the  public,  to  do  the  principal 
work  in  marketing  them,  and  to  guide  the  work  done  by 
others. 

If  the  banker  is  found  wanting  in  any  of  these  respects, 
or  his  judgment  proves  to  be  faulty,  he  loses  the  confidence 
of  those  who  habitually  participate  in  syndicates,  and  with 
it,  his  capacity  to  engage  in  financial  transactions  on  a large 
scale,  as  it  is  only  with  the  co-operation,  financial  or  other- 
wise, of  syndicates  that  large  transactions  can  be  carried 
through. 

Just  as  there  is  a misconception  as  to  the  profits  of  bank- 
ers, so  a misconception  prevails  as  to  the  profits  of  the  syn- 
dicates formed  for  the  purchase  or  underwriting  of  the 
securities  of  railroad  companies.  While  in  the  case  of  under- 
writing the  syndicate  receives  a fixed  commission,  yet,  even 
in  such  cases,  the  transaction  becomes  a purchase  to  the  ex- 
tent that  the  syndicate  is  required  to  take  the  securities  in 
the  case  of  the  partial  or  total  failure  of  the  offering  to 
stockholders. 

In  the  case  of  the  purchase  of  securities  outright,  while, 
naturally,  the  syndicate  is  formed  with  the  expectation  of 
securing  a reasonable  profit  in  compensation  for  its  risk  and 
services,  actually  the  profit  or  loss  to  the  syndicate  depends 
upon  the  success  in  marketing  the  securities.  It  is,  there- 
fore, impossible  to  state  in  definite  terms  the  profits  of  syn- 
dicates, but  it  may  be  said  generally,  taking  the  experience 
of  the  last  ten  years  as  a basis,  that  year  in  and  year  out  those 
who  regularly  participate  in  the  syndicates  formed  by  the 
leading  bankers  for  the  underwriting  or  purchase  of  the 
securities  of  railroad  companies  do  not  realize,  in  the  net 
average  result,  more  than  a fair  rate  of  interest  upon  the 
capital  employed.  There  are,  of  course,  cases  where  a sub- 
stantial profit  is  made,  but  there  are  other  cases  where  losses 
are  sustained.  The  average  is  as  above  indicated,  which  is 
easily  susceptible  of  proof. 

The  normal  margin  of  profit  on  which  the  American 
banker  and  syndicate  figure  in  purchasing  the  securities  of 


16 


railroads  is  approximately  the  same  as  prevails  amongst 
bankers  and  syndicates  in  London,  when  dealing  with  the 
securities  of  corporations  or  of  governments  of  good  stand- 
ing and  credit  (apart  from  those  of  a limited  number  of 
governments,  whose  power,  credit  and  standing  place  them 
in  a class  by  themselves)  and  is  considerably  lower  than  pre- 
vails in  Paris. 

It  is  also  worth  mentioning  that  the  London  banker  does 
not  render  the  same  measure  of  service  to  the  corporations 
whose  securities  he  sells  to  the  public  as  the  American 
banker.  It  is  the  practice  of  the  London  banker,  immediate- 
ly after  the  public  issue  has  taken  place,  to  dissolve  his  syn- 
dicate, distribute  amongst  the  syndicate  participants  any 
bonds  remaining  unsold  and  leave  it  to  them  to  sell  at  the 
best  price  they  can  get. 

The  practice  of  the  American  banker,  on  the  contrary, 
in  cases  where  a public  issue  has  not  resulted  in  placing  with 
the  public  the  entire  amount  offered,  is  to  keep  his  syndicate 
together  (sometimes  for  two  years  and  even  longer),  to  re- 
tain charge  of  the  disposal  of  the  unsold  balance  and  to 
continue  his  efforts  to  place  the  same  with  the  investing 
public  at  the  original  issue  price — a practice  fairer  and 
more  serviceable  both  to  the  railroads  and  to  the  public. 

It  might  be  pointed  out  in  this  connection  that  notwith- 
standing the  practice  of  many  railroads  of  dealing  habitually 
with  particular  bankers,  the  element  of  competition  is  not 
absent,  because  the  price  and  the  margin  of  profit  or  com- 
mission at  which  a banker  concludes  a negotiation  with  a 
railroad  company  for  its  securities  is  necessarily  in  competi- 
tion with  the  terms  upon  which  other  bankers  negotiate 
with  other  railroad  companies  for  their  securities. 

In  addition,  there  is  the  potential  competition  and  safe- 
guard arising  from  the  fact  that  the  railroads  in  most  cases 
are,  and  always  ought  to  be,  entirely  free  to  deal  with  other 
bankers  if  they  deem  the  terms  offered  them  by  their  regular 
banker  inadequate,  or  the  resulting  profit  to  him  excessive, 
or  if  there  is  any  other  reason  which  makes  it  appear  to  the 


17 


railroad  company  that  its  interests  would  be  best  served  by 
having  recourse  to  another  than  its  regular  banking  affilia- 
tion. 

The  prices  at  which  railroads  sell  their  securities  are 
now  generally  matters  of  public  record.  No  banker  expect- 
ing to  maintain  his  regular  connection  with  a railroad  com- 
pany can  do  otherwise  than  pay  fair  value  for  the  securities 
which  it  has  to  sell.  It  is  a matter  of  self-interest  for  him 
to  do  so. 

A banker  who  would  secure  from  a railroad  company  its 
securities  at  lower  prices  than  are  paid  by  other  bankers  to 
other  railroad  companies  under  similar  conditions  for  se- 
curities of  similar  class  and  character,  would  very  soon  lose 
both  the  trust  and  the  custom  of  the  railroads.  In  various 
ways,  indications  do  not  fail  to  reach  railroad  companies 
which  enable  them  to  place  a fair  estimate  upon  the  mar- 
ket value  of  securities  which  they  have  for  sale,  and  no 
Board  of  Directors  could  afford  to  incur  the  opprobrium 
and  responsibility  of  selling  securities  to  their  regular  bank- 
ing connections  otherwise  than  on  the  basis  of  what  they  are 
reasonably  and  fairly  worth,  considering  the  time  and  the 
conditions. 

As  a matter  of  fact,  even  in  the  case  of  those  railroads 
the  management  and  policies  of  which  have  recently  been 
the  object  of  investigation  and  criticism,  the  charge  of  not 
having  secured  adequate  prices  for  such  of  their  securities 
as  were  sold  to  Bankers  has  been  heard  but  little  if  at  all. 

5.  The  advantage  of  access  to  foreign  markets  for  se- 
curities. 

Not  infrequently,  a situation  arises  which  makes  it  of 
vital  importance  to  a railroad  and  of  great  benefit  to  the 
financial  position  of  the  country  to  have  the  European  mar- 
kets opened  for  the  placing  of  important  issues  of  bonds, 
without  having  recourse,  or  more  than  a limited  recourse, 
to  the  American  market. 


18 


Transactions  of  this  nature  are  simply  impossible  of  ac- 
complishment unless  entrusted  to  a particular  American 
banking  house,  because,  owing  to  the  manifold  and  com- 
plex requirements  for  listing  and  other  formalities  in  the 
different  European  countries  (particularly  in  France),  and 
of  the  business  methods,  habits  and  ideas  prevailing  there, 
they  require  weeks  of  negotiations,  the  furnishing  of  a mass 
of  data  and  explanations,  access  to  particular  and  potent 
European  connections  and  much  special  skill  and  experi- 
ence. 

The  placing  of  large  issues  of  American  securities  in 
Europe — which,  as  above  stated,  can  only  be  accomplished 
through  lengthy  and  complex  private  negotiations — would 
be  made  impossible  through  competitive  bidding. 

6.  The  system  in  vogue  in  this  country  also  prevails  in 
Europe,  even  in  the  case  of  most  government  loans. 

In  not  a single  European  country  does  the  system  of  the 
competitive  sale  of  securities  on  the  part  of  corporations  pre- 
vail. Moreover,  most  of  the  Governments,  in  placing  their 
loans,  have  recourse  to  regularly  established  and  continuous 
connections  with  a banking  house  or  a group  of  banking 
houses.* 

7.  The  necessity  of  the  underwriting  by  bankers  of  is- 
sues of  securities  offered  for  pro  rata  subscriptions  to  stock- 
holders. 

o 

Experience  has  shown  that  a very  large  proportion  of  the 
stockholders  to  whom  subscription  rights  are  offered,  sell 
them  in  the  market  with  the  result  that  the  value  of  the  se- 
curity under  offer  declines.  This  very  decline  has  a cumu- 
lative effect  in  causing  other  stockholders  to  sell  and  is  fur- 


*Not  one  of  the  foreign  Governments,  belligerent  or  neutral,  who  since  the 
beginning  of  the  European  war  have  found  access  to  the  American  investment 
market  for  the  securities  of  their  respective  countries  has  had  recourse  to  com- 
petitive bidding  amongst  Bankers  or  otherwise.  In  each  instance  the  Government 
concerned  has  dealt  with  some  one  particular  Banker  or  Group  of  Bankers  whom 
it  selected  as  efficient  and  worthy  of  confidence. 

19 


ther  frequently  intensified  by  short  selling  on  the  part  of 
speculators. 

All  of  these  influences  combine  to  bring  about  the  pos- 
sibility of  the  security  under  offer  declining  below  the  sub- 
scription price,  which  means  the  failure  of  the  offering. 
Moreover,  not  to  mention  the  damage  to  its  credit  in  case 
of  the  failure  of  such  an  offering,  pending  the  time  during 
which  the  securities  are  under  offer  to  the  stockholders — 
usually  not  less  than  from  45  to  60  days — the  railroad  is 
uncertain  whether  or  not,  or  to  what  extent,  the  stockhold- 
ers will  subscribe  and  is,  consequently,  in  doubt  whether,  at 
the  end  of  the  subscription  period,  it  will  come  into  posses- 
sion of  the  funds  it  requires. 

All  of  this  is  obviated  by  the  formation  of  an  underwrit- 
ing syndicate  which  itself  guarantees  to  take  and  pay  for  any 
part  of  the  offering  which  the  stockholders  may  not  want  to 
take.  The  existence  of  such  a syndicate  and  the  resulting 
guarantee  of  the  success  of  the  offering  has  a strong  moral 
effect  upon  the  stockholders  in  encouraging  them  to  sub- 
scribe, and  an  equally  strong  effect  in  discouraging  specu- 
lators from  short  selling,  while  an  unprotected  offering  pre- 
sents a target  to  short  selling. 

The  result  is  that  a railroad  can  safely  afford  to  offer 
securities  at  a much  higher  price  when  underwritten  than 
they  would  risk  fixing  when  not  secured  and  protected  by 
an  underwriting. 

After  taking  into  consideration  the  expense  of  an  under- 
writing syndicate,  a railroad  will  usually  obtain  materially 
higher  net  proceeds  from  an  underwritten  offering,  than 
from  one  not  underwritten,  in  addition  to  the  advantage  of 
being  certain  of  securing  the  required  funds. 

It  is  manifestly  more  advantageous  to  a railroad’s  finan- 
cial position  and  the  maintenance  of  the  price  level  of  its 
securities  to  offer  a security,  even  to  its  stockholders,  at  say 
110,  and  pay  a reasonable  underwriting  commission  rather 
than  to  offer  it  at  par  without  an  underwriting. 


20 


8.  The  considerations  which  influence  a railroad  com- 
pany to  deal  with  a particular  banking  house  are  the  same 
as  those  which  influence  similar  relationships  in  other  lines 
of  business,  as,  for  illustration,  between  the  great  cotton  and 
woolen  mills  and  the  commission  merchants  through  whom 
their  products  are  marketed. 

The  relations  between  the  railroads  and  their  bankers  are 
very  analogous  to  the  relations  between  the  great  cotton  and 
woolen  mills  and  the  commission  merchants  through  whom 
their  products  are  marketed.  A mill  lacking  the  organiza- 
tion or  capital  to  market  its  own  output  usually  establishes 
relations  with  some  particular  commission  house  with  the 
necessary  standing,  selling  organization  and  resources  to 
enable  it  to  insure  a reasonably  steady  market  for  the  mill's 
product  and  to  supply  it  with  funds  when  required. 

No  one  would  seriously  argue  that  the  mill  would  be 
better  off  if,  instead  of  dealing  with  one  particular  commis- 
sion house,  it  remained  free  from  any  such  affiliation  and 
depended  upon  its  ability  to  sell  the  products  of  each  season, 
either  directly  to  the  trade  or  to  the  commission  house  offer- 
ing the  most  favorable  prices  and  terms  in  competition. 
Such  a policy  would  be  so  certain  to  bring  loss  and  eventual- 
ly failure  that  it  would  not  even  be  considered. 

The  mill  needs  the  co-operation  of  its  commission  mer- 
chant, who  not  only  furnishes  special  experience  and  skill 
in  marketing  the  mill’s  products,  but  insures  capital  when 
capital  is  needed  to  enable  the  mill  to  accumulate  stocks 
and  keep  in  operation  during  dull  times.  The  fact  that  a 
mill  deals  exclusively  with  one  commission  merchant  for  a 
period  of  years  does  not  place  it  at  the  mercy  of  that  com- 
mission merchant,  for  the  reason  that  competition  regu- 
lates the  prices  at  which  the  mill’s  products  are  sold  by  the 
commission  merchant  to  the  trade,  and  likewise,  competi- 
tion and  custom  regulate  the  profit  or  commission  earned 
by  the  commission  merchant. 


21 


A commission  merchant  who  charges  exorbitant  com- 
missions or  profits  for  his  services  would  soon  lose  his  trade. 

It  is  a matter  of  common  knowledge  that,  while  many 
mills  have  sufficiently  large  products  and  resources  to  en- 
able them  to  maintain  their  own  selling  organizations,  it 
has  been  found  that,  in  the  long  run,  the  mill  is  better  off  if 
its  products  are  handled  by  a commission  merchant  with 
his  highly  organized  facilities. 

All  this  is  true  of  the  relations  between  a railroad  com- 
pany and  its  banker,  except  that,  unlike  the  mill  with  its 
products,  the  railroad  is  not  in  a position  to  market  its  se- 
curities directly  to  any  advantage  whatever,  except  possibly 
to  the  extent  that,  in  special  cases,  it  is  able  to  sell  securities 
to  its  own  stockholders. 

For  that  reason,  the  railroad  in  marketing  its  securities 
is  even  more  dependent  upon  the  banker  than  is  the  mill 
upon  the  commission  merchant  in  selling  its  products,  be- 
cause, as  already  pointed  out,  the  selling  of  securities  is  a 
much  more  complex  operation  than  the  sale  of  ordinary 
commodities. 

To  market  railroad  securities  on  a large  scale  requires  a 
combination  of  skill,  experience,  capital,  reputation  and 
connections,  both  in  this  country  and  Europe,  that,  from 
the  nature  of  the  case,  can  be  possessed  by  only  a limited 
number  of  concerns  at  any  one  time,  because  most  of  these 
necessary  qualities  only  the  test  of  time  will  produce. 

Just  as  custom  and  competition  and  reason  regulate  the 
profits  of  the  commission  merchant  in  handling  the  products 
of  a cotton  or  woolen  mill,  so  they  regulate  the  profits  of  a 
banking  house  in  handling  the  securities  of  a railroad  com- 
pany. 

9.  The  complexity  of  the  business  of  marketing  se- 
curities. 

The  great  complexity  involved  in  the  sale  of  securities 
will  readily  be  seen  from  a brief  outline  of  the  method 
usually  adopted  in  marketing  a large  issue  of  bonds.  The 


22 


railroad,  in  the  first  instance,  sells  the  issue  to  a strong  bank- 
ing firm.  That  firm  then  associates  with  itself  a syndicate 
consisting  of  many  (sometimes  hundreds)  of  other  bank- 
ing, brokerage  and  investment  houses  in  this  country  and 
Europe. 

Pending  the  formation  of  such  syndicate,  the  firm  which 
has  contracted  with  the  railroad  stands  in  the  breach,  and  is 
responsible  to  the  railroad  whether  or  not  it  succeeds  in 
forming  the  syndicate.  Many  of  these  participants  have 
sub-participants  who  are  sometimes  investors  and  sometimes 
simply  distributors. 

Thus,  begins  the  laborious  process  of  selling  securities 
to  ultimate  investors,  through  advertising,  letters  and  cir- 
culars and  personal  presentation,  and  in  this  labor  are 
usually  engaged  large  numbers  of  dealers  in  securities,  each 
with  his  own  clientele.  In  time,  if  the  issue  is  a success,  the 
securities  are  absorbed.* 

If  not,  the  participants  in  the  syndicate  must  either  sell 
at  a loss  or  carry  them  along  until  the  advent  of  propitious 
times  enables  them  to  dispose  of  them ; and  of  late  years  the 
necessity  of  such  prolonged  carrying  has  been  the  rule, 


•Within  the  past  three  years,  i.e.,  since  1918,  a certain  change  has  taken  place 
in  respect  to  the  processes  of  selling  securities: 

The  operation  of  the  income  tax  has  not  only  cut  down  the  total  of  surplus 
funds  available  for  investment  in  the  hands  of  the  well-to-do,  but  has,  to  a very 
large  extent,  eliminated  the  large  individual  investor  as  a purchaser  of  ordinary 
bonds,  because  he  can  do  far  better  by  buying  tax-exempt  bonds  which  are  obtain- 
able on  a basis  averaging  about  5z/2%  (such  a basis  being  equivalent  to  a yield 
ranging  up  to  20%  on  a taxable  bond,  according  to  the  size  of  the  income  of  the 
holder). 

In  consequence  of  this,  and  for  other  reasons,  the  placing  of  bonds  must  now 
be  effected  to  a far  greater  extent  than  formerly,  in  relatively  moderate  sized  lots. 
That  means  that  the  work  of  distribution  has  become  much  more  laborious, 
difficult,  and  costly  than  formerly  and  requires  the  services  of  a small  army  of 
salesmen. 

The  spread  between  the  purchase  price  and  the  selling  price  of  a security 
must  take  care  not  only  of  the  compensation  of  the  managing  bankers  and  the 
underwriters  or  the  syndicate  participants  in  return  for  their  skill,  services,  re- 
sponsibility, and  risk,  but  also  of  the  commissions  to  be  paid  to  distributing  retail 
houses  throughout  the  country.  Unless  these  latter  commissions  are  sufficiently 
attractive  and  commensurate  with  the  greater  effort  and  cost  required  nowadays, 
the  distributors  simply  will  not  make  adequate  efforts,  inasmuch  as  they  can 
always  obtain  very  liberal  commissions  for  placing  foreign  government  bonds  or 
industrial  bonds,  of  which  there  is  a particularly  continuous  supply  offering  at 
this  time. 


23 


rather  than  the  exception,  and  losses  to  syndicates  and  bank- 
ers have  been  frequent  and  heavy. 

In  this  connection,  it  must  be  borne  in  mind  that  bankers 
do  not  buy  securities  for  permanent  investment  by  them- 
selves. If  the  bankers  permanently  kept  the  securities  which 
they  bought  from  the  railroads  their  capacity  to  buy  secur- 
ities would  soon  be  exhausted.  If  securities  are  to  be  placed, 
they  must  ultimately  find  lodgment  with  investors,  and, 
while  the  amounts  of  securities  taken  by  large  investors, 
such  as  the  life  insurance  companies,  savings  banks  and  very 
rich  men,  seem  to  be  large,  their  aggregate  is  small  compared 
with  the  investments  of  the  rank  and  file  of  smaller  in- 
vestors. 

10.  The  Lesson  of  Experience. 

It  is  a significant  fact  that  practically  all  of  the  railroads 
which  have  gone  into  receivers’  hands  in  recent  years  had 
followed  the  practice  of  selling  their  securities  to  different 
bankers  at  different  times,  and  for  the  financing  of  such 
railroads,  accordingly,  no  single  banking  house  felt  itself 
responsible.* 

Frequently  also  the  difficulty  was  that  a defective  finan- 
cial system,  making  no  adequate  provision  for  the  future, 
had  been  built  up  without  the  advice  of  skilled  bankers.  On 
the  other  hand,  almost  every  successful  railroad  system  in 
this  country,  as  in  Europe,  has  made  it  a practice,  not  only 
to  arrange  with  bankers  for  the  sale  or  underwriting  of  its 
securities,  but  to  deal  with  some  particular  banking  house 
of  recognized  strength  and  standing  and  European  connec- 
tions, and  to  deal  principally  with  that  banking  house  unless, 
for  some  reason,  it  chooses  to  change  its  bankers. 

This  has  been  true , not  only  of  the  railroad  companies 
which  through  reorganization  or  otherwise  have  come  to  be 

♦(Examples:  Wabash,  Western  Maryland,  Wheeling  & Lake  Erie,  Kansas  City, 
Mexico  & Orient,  St.  Louis  & San  Francisco,  Norfolk  & Southern,  Chicago  'Great 
Western,  etc.). 


24 


closely  identified  with  some  one  banking  house,  but  also  of 
those  whose  management  or  control  is  entirely  independent 
of  any  banking  house  or  group  of  bankers,  and  which  can 
have  no  possible  inducement  for  habitually  dealing  with  a 
particular  banking  house  except  the  conviction  that  their 
best  interests  are  served  by  doing  so. 

CONCLUSION 

To  compel  railroads  to  have  recourse  for  the  sale  of  their 
securities  to  competitive  bidding  on  the  part  of  bankers  and 
brokers,  or  to  direct  offerings  to  the  public,  would  be  to  run 
counter  to  the  practice  and  experience  of  every  country  in 
the  world.  It  would  confuse  and  trouble  the  investing  pub- 
lic and  destroy  elements  and  features  of  evident  and  proved 
value  for  its  protection,  in  that  it  would  make  the  possession 
of  capital  the  sole  requisite  for  dealing  in  securities,  irre- 
spective of  skill,  care,  reputation  and  the  confidence  of  in- 
vestors. It  would  limit,  hamper  and  restrain  the  flow  of 
capital  ( both  of  home  capital  and  still  more  of  European 
capital ) into  American  securities  and  cause  delay,  uncer- 
tainty, damage  and  serious  risk  to  American  corporations. 
Railroads  and  other  corporations  should  be  left  free,  under 
the  responsibility  of  their  Boards  of  Directors,  to  deal  with 
whatever  banking  houses  they  deem  it  in  their  best  interest 
to  employ.  They  should  neither  be  bound  by  contract  or 
control  to  deal  with  any  one  banking  house  exclusively , nor 
forced  by  statute  or  regulation  to  take  the  chances  of  com- 
petitive bidding  or  of  direct  dealing  with  the  public. 

Examples 

The  following  are  a few  illustrative  instances  of  railroad 
companies  benefiting  from  the  relations  which  exist  between 
them  and  their  bankers: 

(a)  In  March,  1903,  the  Pennsylvania  Railroad  offered 
to  its  stockholders  $75,000,000  of  stock  at  120  per  cent.,  the 
market  price  at  the  time  being  about  145  per  cent.  Owing 
to  the  large  difference  between  the  market  price  and  the 


25 


price  of  the  offer,  the  railroad  deemed  it  unnecessary  to 
have  the  issue  underwritten.  Gradually,  as  stockholders  sold 
their  rights,  a decline  set  in  which  reached  such  propor- 
tions that  in  May  the  market  price  had  come  down  to  l2Sy2 
per  cent.,  and  the  failure  of  the  railroad’s  offering  appeared 
imminent.  To  avoid  this  and  its  resulting  grave  conse- 
quences, the  railroad  finally  requested  its  bankers  to  form  a 
syndicate  to  underwrite  the  issue,  which  was  done.  The 
reassuring  effect  upon  the  stockholders  of  the  mere  public 
announcement  that  a syndicate  had  guaranteed  to  take  and 
pay  for  any  part  of  the  offering  which  was  not  subscribed 
for  by  the  stockholders,  was  such  as  to  arrest  immediately 
the  selling  on  the  part  of  alarmed  stockholders  as  well  as 
speculative  short  selling,  and  to  stop  the  decline  in  the  mar- 
ket, and  to  turn  a threatened  failure  into  an  entire  success. 

( b ) The  experience  of  the  City  of  New  York  with  its 
public  offerings  of  bonds  is  illustrative.  In  at  least  one 
instance  in  recent  years  the  city  was  compelled,  in  order  to 
avoid  total  failure  of  a large  issue  to  meet  its  pressing  re- 
quirements, to  have  recourse  to  one  of  the  leading  banking 
houses,  and  in  many  instances  of  late  it  was  only  large  sub- 
scriptions by  such  banking  houses — made  often  without  any 
expectation  of  profit,  and  resulting  frequently  in  losses — 
which  avoided  the,  at  least  partial,  failure  of  the  public 
offerings  of  the  bonds  of  the  City  of  New  York. 

(c)  In  September,  1905,  The  Erie  Railroad  arranged 
with  its  bankers  to  form  a syndicate  to  underwrite  the  offer 
to  its  shareholders  at  100  per  cent,  of  $12,000,000.  Convert- 
ible 4 per  cent.  Bonds,  Series  “B,”  (convertible  into  common 
stock  at  $60  per  share).  The  result  of  the  offering  was 
that  the  stockholders  subscribed  for  only  18  per  cent,  and, 
consequently,  the  syndicate  had  to  take  and  pay  for 
$9,840,000  of  the  bonds.  The  syndicate  was  dissolved  in 
December,  1906,  none  of  the  bonds  taken  by  it  having  been 
disposed  of.  The  bonds  were  listed  on  the  Exchange  in  Feb- 
ruary, 1907,  when  they  sold  at  85. 

(d)  In  March,  1905,  the  Pennsylvania  Railroad  ar- 


26 


ranged  with  bankers  to  form  a syndicate  to  underwrite  the 
offer  to  its  shareholders  at  par  of  $100,000,000  Pennsylvania 
Railroad  3j4  per  cent.  Convertible  Bonds  (convertible  into 
stock  at  150  per  cent.).  The  result  of  the  offering  was  that 
the  stockholders  subscribed  for  less  than  10  per  cent,  and 
that,  consequently,  the  underwriting  syndicate  had  to  take 
and  pay  for  about  $90,000,000  of  the  bonds.  The  bonds 
within  the  year  declined  to  97  y2  per  cent,  and  never  again 
reached  par,  the  price  at  which  they  were  first  offered.  If 
it  had  not  been  for  the  underwriting  syndicate,  the  situa- 
tion resulting  from  the  failure  of  the  stockholders  to  sub- 
scribe and  thus  provide  the  money  needed  by  the  railroad, 
would  have  been  very  embarrassing  to  the  railroad  and  very 
serious  in  its  effect  upon  the  general  financial  and  invest- 
ment situation  of  the  country. 

(e)  In  January,  1906,  The  Missouri,  Kansas  & Texas 
Railway  arranged  with  its  bankers  to  form  a syndicate  to 
underwrite  the  offer  to  its  shareholders  at  87 y2  per  cent,  of 
$10,000,000  General  Mortgage  4J4  per  cent.  Bonds.  The 
result  of  the  offering  was  that  the  stockholders  subscribed 
for  only  50  per  cent,  and  the  syndicate  had  to  take  5,000,000 
of  the  bonds.  The  syndicate  was  dissolved  in  December, 
1907,  only  a few  of  the  bonds  taken  by  it  having  been  dis- 
posed of. 

(/)  In  1904  the  interests  in  control  of  the  “Gould  Sys- 
tem,” made  up  of  the  Missouri  Pacific,  Iron  Mountain, 
Denver  & Rio  Grande  and  Rio  Grande  Western  lines, 
deemed  it  important,  in  their  competition  with  the  Union 
Pacific  and  other  transcontinental  systems,  to  create  an  out- 
let to  the  Pacific  Coast  by  building  the  Western  Pacific 
Line  from  Salt  Lake  City  to  San  Francisco.  The  companies 
in  the  Gould  System  were  not  strong  enough  to  secure  the 
money  for  the  construction  of  this  line,  either  by  the  sale 
of  securities  to  their  own  stockholders  or  otherwise.  They 
accordingly  called  in  a syndicate  of  bankers,  who,  after 
months  of  study  and  negotiation,  worked  out  a plan  for  the 
creation  of  an  issue  of  $50,000,000  of  bonds  of  the  Western 


27 


Pacific  Company  guaranteed  by  the  Denver  & Rio  Grande 
Company,  which  bonds  were  purchased  by  a syndicate 
formed  by  these  bankers.  After  the  Western  Pacific  Line 
was  partially  completed,  it  was  found  that  the  proceeds  of 
the  $50,000,000  bond  issue  were  insufficient  to  complete 
and  equip  the  line,  and  the  bankers  who  placed  the  origiaal 
issue  of  bonds  advised  the  creation  of  an  issue  of  refunding 
mortgage  bonds  and  purchased  $15,000,000  of  3-5  year 
notes  secured  by  bonds  of  that  issue.  At  a later  date,  viz., 
in  1912,  when  the  refunding  bonds  had  been  exhausted  and 
still  further  money  were  required,  the  same  bankers  advised 
the  creation  of  Adjustment  Seven  Per  Cent.  Bonds  of  the 
Denver  & Rio  Grande  Railroad  Company  and  formed  a 
syndicate  to  underwrite  $10,000,000  of  these  bonds  which 
were  offered  to  the  shareholders.  The  result  was  that  the 
shareholders  subscribed  for  practically  none  of  the  bonds, 
and  the  syndicate  consequently  had  to  take  and  pay  for 
almost  the  entire  issue,  the  bulk  of  which  it  still  holds,  the 
market  price  of  the  bonds  having  meanwhile  declined  25 
per  cent,  below  the  price  at  which  the  syndicate  acquired 
them. 

It  is  highly  probable  that  if  the  law  had  required  the 
public  offering  of  securities  or  even  if  the  Gould  System 
had  not  been  free  to  deal  preferentially  with  some  partic- 
ular banking  group,  the  original  $50,000,000  of  bonds  for 
the  construction  of  the  Western  Pacific  Line  could  not  have 
been  placed.  It  is  certain  that  the  system  would  not  have 
been  able  to  meet  the  emergencies  on  the  two  subsequent 
occasions  when  it  was  found  that  large  additional  sums 
were  required  to  carry  the  enterprise  to  completion.  It 
was  the  support  of  the  bankers  who  were  identified  with 
the  orgiinal  $50,000,000  bond  issue  and  therefore  morally 
committed  to  its  support  that  carried  the  enterprise 
through.  It  should  be  added  that,  after  the  purchase  by 
the  bankers,  each  of  the  three  issues  declined  in  market 
value.  Indeed,  the  decline  in  market  value  of  the  $50,000,- 
000  of  bonds  originally  issued  was  so  substantial  that  it 


28 


would  have  been  impossible  for  the  railroad  companies  to 
market  additional  securities  by  an  offering  to  the  public,  or 
to  stockholders,  or  in  any  other  manner  that  did  not  involve 
the  strong  support  of  bankers  who  had  a direct  interest  in 
supporting  the  enterprise. 

(g)  In  May,  1907,  the  Union  Pacific  arranged  with  its 
bankers  to  form  a syndicate  to  underwrite  the  offer  to  its 
stockholders  at  90  per  cent,  of  $75,000,000  4 per  cent.  Con- 
vertible Bonds  (convertible  into  stock  at  175  per  cent.). 
The  result  of  the  offering  was  that  the  stockholders  sub- 
scribed for  barely  5 per  cent.,  and  that,  consequently,  the 
syndicate  had  to  take  and  pay  for  about  $70,000,000  of  the 
bonds.  The  bonds  in  the  course  of  the  following  six  months 
declined  to  78*4  Per  cent. 

( h ) In  January,  1913,  the  Baltimore  & Ohio  Railroad 
Company  arranged  with  its  bankers  to  form  a syndicate  to 
underwrite  the  offer  to  its  stockholders  at  95}4  per  cent, 
of  $63,000,000  4*4  per  cent.  Convertible  Bonds  (convertible 
at  110  per  cent.).  The  result  of  the  offering  was  that  the 
stockholders  subscribed  for  barely  30  per  cent,  and,  con- 
sequently, the  syndicate  had  to  take  and  pay  for  about 
$44,000,000  of  the  bonds.  In  the  course  of  a few  months 
the  bonds  declined  to  88*4  per  cent. 

(i)  In  April,  1906,  the  Wisconsin  Central  Railway  ar- 
ranged with  bankers  to  form  a syndicate  to  underwrite  the 
offer  to  its  shareholders  at  89  per  cent,  and  interest,  of 
$7,000,000  Superior  & Duluth  Division  & Terminal  First 
Mortgage  4 per  cent.  Bonds.  The  result  of  the  offering 
was  that  the  stockholders  subscribed  for  only  1 per  cent,  and 
the  syndicate  had  to  take  $6,930,000  of  the  bonds.  The  syn- 
dicate expired  by  limitation  July  1,  1908,  none  of  the  bonds 
taken  by  it  having  been  disposed  of  in  the  interval. 

(j)  In  March,  1910,  The  Atchison,  Topeka  & Santa  Fe 
Railway  Company  arranged  with  its  bankers  to  form  a 
syndicate  to  underwrite  the  offer  to  its  shareholders  at  102}4 
per  cent,  of  $43,686,000  Convertible  4 per  cent.  Bonds  due 
1960.  The  result  of  the  offering  was  that  the  stockholders 


29 


subscribed  for  only  about  12 y2  per  cent.,  leaving  about  $38,- 
226,000  of  the  bonds  to  be  taken  by  the  syndicate. 

( k ) In  June,  1906,  when  the  investment  market  in  this 
country  was  practically  at  a standstill,  American  bankers 
placed  an  issue  of  Francs  250,000,000  Pennsylvania  Com- 
pany 3 Y\  per  cent.  Bonds  in  France;  in  February,  1907,  an 
issue  of  Francs  145,000,000  New  York,  New  Haven  & 
Hartford  Railroad  Company  4 per  cent.  Bonds  in  France 
and  Germany;  in  March,  1910,  an  issue  of  Francs  150,000,- 
000  Chicago,  Milwaukee  & St.  Paul  4 per  cent.  Bonds  in 
France  and  England;  and  in  February,  1911,  an  issue  of 
Francs  250,000,000  Central  Pacific  Railway  Company  4 per 
cent.  Bonds  in  France  and  England.  All  of  these  loans 
were  negotiated  at  times  when  it  was  of  great  advantage 
to  the  railroads  as  well  as  to  the  general  financial  situation 
to  obtain  money  abroad.  They  took  many  weeks  of  pre- 
liminary negotiation  and  could  not  possibly  have  been  nego- 
tiated on  a competitive  basis. 

(/)  In  January,  1909,  the  Western  Maryland  Railroad 
sold  to  bankers  $6,500,000  First  Mortgage  4 per  cent.  Bonds. 
On  January  18,  1909,  about  90  per  cent,  of  the  bonds  had  to 
be  taken  up  by  syndicate  participants.  No  bonds  were  dis- 
posed of  by  the  syndicate  until  September,  1910,  and  from 
then  on,  at  various  dates  up  to  February  28,  1911 ; thus,  the 
syndicate  lasted  more  than  two  years. 

(m)  In  1908,  a situation  had  arisen  which  had  brought 
the  market  for  railroad  bonds  in  this  country  to  a complete 
standstill.  Railroads  for  many  months  were  unable  to 
obtain  funds,  except  to  a limited  extent,  by  means  of  the 
costly  and  dangerous  expedient  of  selling  short  term  notes. 
The  effect  was  cumulative  and  far-reaching  and  threatened 
to  bring  about  serious  consequences.  At  this  juncture  the 
bankers  of  the  Pennsylvania  Railroad  succeeded  in  inducing 
the  two  foremost  banking  houses  in  England,  Messrs.  N. 
M.  Rothschild  & Sons,  and  Messrs.  Baring  Brothers  & Co., 
Ltd.,  (the  former  of  whom  had  not  issued  an  American 
security  for  many  years)  to  purchase  and  bring  out  jointly 


30 


with  them  at  96  per  cent,  an  issue  of  $40,000,000  Penn- 
sylvania Railroad  4 per  cent.  Consolidated  Bonds.  Largely 
in  consequence  of  the  prestige  and  placing  power  and  in- 
vestment following  of  the  issuing  houses,  the  public  offer- 
ing was  a complete  success  and  its  effect,  as  recognized  by 
many  published  comments  here  and  abroad,  was  to  break 
the  deadlock  which  had  existed,  and  to  cause  capital  to  flow 
again  freely  into  the  investment  market. 

(n)  In  June,  1909,  the  Seaboard  Air  Line  arranged  with 
bankers  for  the  formation  of  a syndicate  to  guarantee  the 
sale  of  $18,000,000  Adjustment  Bonds  at  70  per  cent. 
November  1,  1909,  syndicate  members  took  up  about  90  per 
cent,  of  the  bonds,  which  were  disposed  of  in  small  lots 
between  February,  1910,  and  November  30,  1910,  the  syndi- 
cate thus  lasting  about  one  and  one-half  years. 

(o)  In  August,  1913,  bankers  formed  a syndicate  to 
underwrite  the  offer  to  Union  Pacific  stockholders  of  $88,- 
000,000  Southern  Pacific  Stock  Trust  Certificates  at  92  per 
cent.  The  effectuation  of  that  sale  was  of  very  great  impor- 
tance as,  failing  it  by  a certain  very  near  date,  the  Southern 
Pacific  stock  in  question  would  have  been  placed,  under 
the  Court’s  decree,  into  the  hands  of  a Receiver,  the  senti- 
mental and  actual  effect  of  which  course  would  have  been 
grave.  In  the  face  of  many  predictions  that  a syndicate 
to  guarantee  the  sale  of  so  vast  an  amount  of  stock  could 
not  be  formed  under  the  then  prevailing  generally  disturbed 
and  unfavorable  conditions,  the  bankers,  with  the  aid  of 
their  connections  throughout  America  and  Europe,  suc- 
ceeded in  the  undertaking,  the  syndicate  as  finally  made  up 
consisting  of  nearly  a thousand  participants.  It  is  entirely 
safe  and  well  within  bounds  to  say  that  if  that  mass  of  stock 
had  been  offered  without  guarantee  and  protection  of  an 
■underwriting  syndicate,  it  would  not  have  been  sold — if  at 
all,  within  the  time  limit  set  by  the  Court — at  a price  aver- 
aging better  than  8o  per  cent. 

(p)  In  connection  with  the  first  plan  for  the  dissolution 
of  the  Union  Pacific-Southern  Pacific  combination  ap- 


31 


proved  by  Attorney  General  Wickersham  (which  failed  of 
adoption  because  of  the  refusal  of  the  California  Railroad 
Commission  to  approve  certain  of  its  features)  he  imposed 
the  condition  that  the  sale  of  the  Union  Pacific  Company’s 
holdings  of  Southern  Pacific  stock,  which  would  be  offered 
for  pro  rata  purchase  to  the  stockholders  in  the  Southern 
Pacific  Company,  should  be  underwritten  by  a syndicate. 
He  imposed  this  condition  for  the  manifest  reason  that  the 
sale  of  the  stock,  however  attractive  the  price  to  the  stock- 
holders might  be,  could  only  be  insured  in  case  definite 
arrangements  were  made  for  a sale  of  the  stock  that  might 
not  be  taken  by  the  stockholders  upon  the  offering. 

( q ) In  January,  1910,  bankers  purchased  $22,000,000 
Chicago  City  & Connecting  Railways  Collateral  Trust  5 per 
cent.  Bonds,  and  formed  a syndicate  at  91  per  cent.  The 
Syndicate  expired  in  February,  1912,  leaving  syndicate 
members  with  almost  90  per  cent,  of  the  total  amount  unsold 
in  their  hands. 

(r)  To  quote  only  one  instance,  typical  of  a great  many, 
of  syndicate  operations  in  Europe:  A loan  for  $20,000,000 
Bonds  of  the  Dominion  of  Canada  was  recently  issued  in 
London.  The  public  subscribed  to  but  $3,400,000,  the  bal- 
ance, i.  e.,  $16,600,000  or  83  per  cent,  of  the  total  loan,  being 
left  on  the  hands  of  the  underwriting  syndicate.  It  may 
safely  be  stated  that  a majority  of  the  underwriting  or  pur- 
chasing syndicates  formed  in  Europe  during  the  last  18 
months  have  resulted  in  syndicate  members  being  compelled 
to  take  a large  proportion  of  the  securities  purchased  or 
underwritten,  which  they  must  either  carry  along  for  an 
indefinite  period  of  time  or  sell  as  best  they  can. 


32 


Conway  Printing  Co.,  New  Yor 


